Avoiding Loss of Capital

In the September 2013 issue of AAII, there is a section on debunking stock investing myths. One myth is that paper losses do not matter. Something I was taught when starting out.

Supposedly, since losses are not locked in, they are only temporary. I always found this strange and now I realize that it is wrong.

Stock are liquid assets which are marked to market. If you buy a stock for $1000 and it goes down 20%, it’s foolish to think that the value of your holdings is still $1000, simply because you haven’t locked it in. Avoiding permanent loss of capital is important, but also working to avoid loss of capital is equally important. In the short term anything can happen, that’s why margin of safety is so important.

Tell Me Where I’m Going To Die, So I Won’t Go There

One thing that Charlie Munger does so well is to focus on eliminating the bad and letting the good take care of itself.

“Tell Me Where I’m Going To Die, So I Won’t Go There” Munger

There is a deeper meaning to this quote.

It’s having the power to say “no”. It’s scary, but it works. Instead of trying to find a winning formula for everything, stick to the basics of not doing the things that aren’t going to work.

Say you aren’t as analytical as some investors. Then instead of trying to expand into an area that you are not comfortable with, just stick to something simple.

Buffett called this staying within your circle of competence.

3 Simple Ideas to Avoid in Order to Make Money in the Stock Market

Avoid companies using obsolete methodology and technology

Stay away from companies with too much leverage

Avoid stocks with shrinking competitive advantages

1. Avoid Companies Using Obsolete Methodology and Technology

Obsolete technology can bog a company down

Kodak went bankrupt by ignoring the fact that film was out and digital cameras were here to stay.

Blockbuster went bankrupt because it was unable to defend itself from Netflix and the new era of streaming and “renting” movies.

Newspapers are on the way out as everything goes digital.

CD’s and DVD’s are dying and that’s why a net net stock like Imation (IMN) continues to stay a net net.

Companies like IBM (IBM) and Seagate (STX) adapted to change and new technology to become stronger. But as Munger said above, it is easier to avoid the bad ones instead of hunting for the next Google.

2. Stay Away from Companies with Too Much Leverage

Leverage. It can make you do crazy things. | Credit: Some child. I think..

The whole point of using leverage is to magnify your returns.

There is a long and detailed discussion of whether high debt companies achieve higher returns. In theory, the concept is true, but in reality, it’s very difficult to maintain high returns simply because there are so many different variables that can affect it.

If the economy turns, no matter how good the business is, it can run into trouble.

The first thing in personal finance is to eliminate debt. People are irresponsible when it comes to leverage and many companies are as well.

Going back to how Buffett interprets financial statements, Buffett says that durable competitive advantages carry little to no long term debt because the company is so profitable that even expansions or acquisitions are self financed.

Buffett’s historic purchases indicate that on any given year, the company should have sufficient yearly net earnings to pay all long term within 3 or 4 year earnings period. (e.g. Coke + Moody’s = 1yr).

3. Avoid Stocks with Shrinking Competitive Advantages

Competitive Advantage. It can go from a lake to a swamp.

My fault.

This one isn’t as simple. There is a lot of qualitative research that goes into this one. The easy way is to first understand the different types of moats that exist and then to check for yourself.

We are driven to provide useful value investing information, advice, analysis, insights, resources, and education to busy value investors that make it faster and easier to pick money-making value stocks and manage their portfolio.

Disclaimer: Old School Value LLC, its family, associates, and affiliates are not operated by a broker, a dealer, or a registered investment adviser. Under no circumstances does any information posted on OldSchoolValue.com represent a recommendation to buy or sell a security. The information on this site, and in its related application software, spreadsheets, blog, email and newsletters, is not intended to be, nor does it constitute, investment advice or recommendations. In no event shall OldSchoolValue.com be liable to any member, guest or third party for any damages of any kind arising out of the use of any product, content or other material published or available on OldSchoolValue.com, or relating to the use of, or inability to use, OldSchoolValue.com or any content, including, without limitation, any investment losses, lost profits, lost opportunity, special, incidental, indirect, consequential or punitive damages. Past performance is a poor indicator of future performance. The information on this site, and in its related blog, email and newsletters, is not intended to be, nor does it constitute, investment advice or recommendations. The information on this site is in no way guaranteed for completeness, accuracy or in any other way.